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06 May 2014

US oil boom checks inflation

Kevin Logan

by Kevin Logan

Chief US Economist, HSBC

US oil boom checks inflation

The US and Canada accounted for 90 per cent of the increase in global oil production between 2008 and 2013

US oil production has far surpassed expectations in recent years and the country could overtake Saudi Arabia to become the world’s largest producer of crude oil and oil products by 2015.

The US and Canada accounted for 90 per cent of the increase in global oil production between 2008 and 2013, according to US Energy Information Administration (EIA) estimates. US production rose 9.6 per cent in 2012 and 10.6 per cent in 2013, taking it back above the 1985 peak that preceded two decades of more or less steady decline. The EIA is predicting further increases averaging about 7.5 per cent for both this year and next.

But since 2005, US consumption of oil and petroleum products has fallen 9.2 per cent, reducing imports and making more oil available for countries where demand is still rising. The availability of sufficient supply to meet demand is the main reason oil prices have been stable for the past three years.

The World Bank estimates that nearly 90 per cent of known oil reserves and about 70 per cent of global oil production are controlled by government-run national oil companies. While private oil companies plough some of their profits back into investment to increase future production, profits at national oil companies are often diverted to other purposes.

The importance of increasing US production for growing global oil markets should not be underestimated

However, ownership of oil resources and production in the US and Canada is mostly private and the structure of the energy businesses there favours risk-taking and the financing of exploration. Also, besides large integrated oil companies, numerous private firms of varying size are involved in the industry, allowing a flexibility in exploration and production absent in many other economies.

The importance of increasing US production for growing global oil markets should not be underestimated. In 2008, increasing world demand and stagnant supply eventually resulted in a price spike so severe it could be considered one cause of the ensuing world recession.

That recession drove down oil prices temporarily, but once economic expansion resumed in 2010, oil prices quickly returned to 2008 levels. Had global supplies remained stagnant, prices probably would have increased again as demand for energy products grew in line with rising incomes, especially fast-growing incomes in emerging-market economies.

But instead, oil prices trended sideways, mainly because the growth in oil demand outside the US was supplied by a decline in oil imports to the country.  Without the boom in US and Canadian oil production we estimate benchmark prices such as North Sea Brent might have jumped as high as USD175 a barrel, well above the recent average of around USD110.

This downward pressure on the oil price has translated into reduced core inflation in the US and ongoing increases in US and Canadian oil output should have a restraining effect on core inflation for several years.

Exactly when the US Federal Reserve starts to raise interest rates, and how fast they rise, will depend to a large extent on the outlook for inflation. The chances that headline and core inflation will stay below 2 per cent through 2015 are more likely if oil prices continue to be held down by sizable production increases in the booming US and Canadian oil industries.

This research was first published on 24 April 2014.